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Record Year In Reach For Spinoffs Thanks To Activist Appetite, Sluggish Growth

Time Inc executives ring the NYSE opening bell June 9. The magazine publisher is part of the latest crop of corporate spinoffs, a subset of the stock market that has delivered eye-popping returns in recent years. (AP Photo/Richard Drew)

Corporate spinoffs were growing in popularity in August 2011 when the snack company Mondelez International — formerly Kraft Foods — decided its North American grocery business no longer fit as part of the family.

Bright prospects in European and emerging markets shined a critical light on the lagging performance of that business, now called Kraft Foods GroupKraft Foods Group, and its meager profit growth. By October 2012, Mondelez finally freed itself from its slow-growth grocery business, but two and a half years later it turns out that both businesses have found favor with investors.

Kraft Foods has revitalized its business by finding ways to cut operating costs and enhance the productivity of its manufacturing processes, helping operating income grow by 62% and lifted its stock price 33%, rivaling the 35% gain by former parent Mondelez.

That marks just one example where both parent and spinoff have been winners for investors, and the track record of such corporate restructuring continues apace. Since the Kraft Foods separation, more than 100 other businesses have been spun off from their former corporate parents into independent public companies, and investors are noticing. The Guggenheim Spin-Off ETF, which tracks an index of spun-off companies, has gained 224.7% over the last five years, compared with 106.2% for the S&P 500, and assets have swelled from $7 million to $834 million.

The most recent corporate spinoff is the separation of B/E Aerospace into one manufacturing-focused company and another service-oriented company. Upon the announcement of the breakup, shares of the Wellington, Fla.-based company tumbled 5%

“Companies that are smaller and more focused usually run better and management tends to get their performance up. When they are out of a spin-off by 12 or 24 months, they usually start heading in the right direction,” says Joe Cornell, publisher of Spin-Off Research. “Portfolio managers don’t want to invest in something that is 8 or 10 different businesses. They prefer to invest in ‘pure plays’,” he adds.

By the end of 2014, Cornell expects to see up to 45 or 50 spinoff announcements, a number Corporate America hasn’t seen since the early 1990’s.

Mark Foster, chief investment officer at Columbus, Ind.-basedKirr Marbach, notes that the rise of spinoffs has come as activist investors raise their voices in the public and in corporate boardrooms, which is no coincidence.

“The rise of the activist has led to more spinoffs than what there has been historically,” says Foster. “They’re trying to get management to do things to get share prices up” and in some cases that means unloading a business that no longer fits the corporate profile. “You also have a flow economy, which is grinding ahead,” he continues, so as a company trying to find ways to generate shareholder value … the ability to do that through spinoffs works its way up,” he added.

Don’t expect to see the number of corporate spinoff announcements slow down anytime in the near future either. According to Foster, activists’ suggestions are generating such attractive numbers that management teams are becoming increasingly receptive to their opinions.

For example, on May 30, Oil States International completed the spinoff of its accommodations business, Civeo Corporation, after facing mounting pressures from activist hedge funds including David Einhorn’s Greenlight Capital and Barry Rosenstein’s Jana Partners. Cornell thinks Civeo shares, which have already rallied 10% to almost $25, have another 50% of upside.

Other success stories from this past year include drilling company North Atlantic Drilling, which was spun off from deepwater drilling company SeadrillSeadrill in January 2014. Within four short months, North Atlantic Drilling forged an eight-year rig contract with Russian oil giant RosneftRosneft. Since news of the deal hit on May 26, North Atlantic’s stock has already climbed 14.4%.

Even with the success that activists have had, not every breakup pitch is so warmly received. Carl Icahn’s push for eBayeBay to cleave off its PayPal division was met with staunch resistance and ultimately proved fruitless. Though it is worth wondering if the recent decampment of PayPal chief David Marcus to Facebook means that story is ripe for a revival.

It’s also important to mention that not every corporate breakup proves to be a winner, and some have stumbled right from the start. Land’s End was spun off from Sears Holding in March, and its stock has dropped almost 20% through Wednesday, but bounced back 10% after better than expected quarterly results. Time Inc, the magazine publisher that was spun out of Time Warner this week, is up modestly since shares began trading on a when-issued basis but down 2% from the formal completion of the spin Monday.

As long as growth remains challenging and activists investors keep clamoring for change, Cornell figures spinoffs will keep up their rapid pace, but even he acknowledges that a broader market or economic slowdown could slow things to a crawl.

“When the economy goes into a recession, these things tend to slow down,” he says. “Companies don’t like to spin something off into an ‘iffy’ economy because they don’t want something to go bankrupt. They like to give the business a fighting chance.”

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